Chapter 1 - Introduction
1.1 New Zealand businesses are following the worldwide move to adopt what are known as International Financial Reporting Standards (or IFRS) for financial reporting purposes. The adoption of IFRS has been allowed from 1 January 2005, and is mandatory for financial reports for periods beginning on or after 1 January 2007.
1.2 The adoption of IFRS will introduce significant changes into New Zealand’s financial reporting practices. Because current taxation policies are linked to some accounting practices, changes to the accounting practices brought about by IFRS need to be reviewed to ensure that tax law continues to meet the needs of modern business practice and to maintain the principles and integrity of the tax system.
1.3 This issues paper considers the tax policy issues that could arise from the adoption of IFRS within the context of existing policy on alignment between tax and accounting. As such, it does not propose to consider a comprehensive alignment of tax legislation with accounting standards at this time.
1.4 The paper examines areas where tax legislation is currently aligned with specific accounting standards or generally accepted accounting practice (or GAAP), with a view to ensuring that taxpayers can continue to use the accounting standards under IFRS for taxation purposes. Other possibilities for alignment are also considered because significant changes have been introduced in these areas under IFRS that seem relevant for taxation purposes.
1.5 The technical discussions in this paper relate to the trading stock rules, research and development expenditure, financial arrangements, revenue recognition, GAAP and implementation issues that could arise from possible legislative changes.
1.6 The paper suggests a number of changes to the relevant tax rules. After analysis of submissions on the suggested changes, we will make formal recommendations to the government on what we think the resulting legislative changes should be.
1.7 We expect to recommend that the changes be included in a bill to be introduced in mid-2007, with legislation likely to be enacted in late 2007. The changes would generally apply from the 2008-09 income year.
- Trading stock valuation rules should continue to be aligned with the valuation methods adopted for accounting purposes, but references to FRS-4 and FRS-1 should be amended to refer to NZ IAS 2 and NZ IAS 8, respectively.
- Primary sector taxpayers who are using NZ IAS 41 should be allowed to use the simplified cost method and market value method, designed for low turnover traders, to value their trading stock.
Research and development
- The core standards governing the accounting treatment of R&D expenditure under NZ IAS 38 are substantially the same as those under FRS-13 and should continue to be appropriate for taxation purposes.
- Minor legislative amendments will be necessary to adjust the references to FRS-13 and to remove references to paragraphs 5.4 and 2.3 of FRS-13 because those standards are no longer applicable under IFRS. However, it may be necessary to ensure that immaterial R&D expenditure that has been written off for financial reporting purposes is subjected to the appropriate standards in NZ IAS 38 before they are allowed as a deduction for taxation purposes.
- The financial arrangement rules should continue to define and govern the taxation of financial arrangements, including derivatives, for taxation purposes. Taxpayers should be able to continue to use the methods prescribed under the financial arrangement rules to calculate the income and expenditure of financial arrangements.
- Taxpayers will be allowed to use the financial reporting methods under NZ IAS 39 for taxation purposes, subject to adjustment for credit impairments unless the impairments are deductible under section DB 23.
- The tax treatment of bad debts should not be aligned with the treatment of credit impairments under NZ IAS 39. A deduction for credit impairment should be allowed for taxation purposes only if the bad debt deductibility rules in section DB 23 of the Income Tax Act 2004 are satisfied.
- The IFRS accounting treatment of fees that are an integral part of a financial arrangement is similar to that of the current taxation rules in substance. Therefore the tax treatment should be explicitly aligned in legislation with financial reporting treatment.
- Derivative instruments that are part of a cash flow hedge or a hedge of net investments in a foreign operation should continue to be taxed under the financial arrangement rules, as they are presently.
- The underlying items in a fair value hedge should continue to be taxed as if they were not part of a hedge.
- Revenue recognition for taxation purposes should continue to follow the accounting practice, which has been formalised in NZ IAS 18, although Inland Revenue should monitor the interpretation and application of the standards for taxation purposes.
- The recognition of warranty income as a separate revenue stream and the spreading of warranty income over the term of the warranty under NZ IAS 18 is an appropriate revenue recognition approach for taxation purposes.
- Legislative amendment may be required to ensure that provisions for warranty costs, which could arguably still be deductible in accordance with the principles established in CIR v Mitsubishi Motors NZ Ltd, are not deductible at the time of sale if the revenue from warranty contract is deferred under NZ IAS 18.
- Legislative amendment will be necessary to recognise as income the amount of previously unrecognised income that has been recorded directly to the shareholders’ funds during the transition year.
Generally accepted accounting practice – GAAP
- The use of “generally accepted accounting practice” in tax legislation is ambulatory in that as GAAP changes with the adoption of IFRS for financial reporting purposes, these changes will be accepted for taxation purposes. Legislative changes to deal with unexpected tax consequences arising from these provisions after the adoption of IFRS should be considered where appropriate.
- The suggested legislative changes should generally apply from the 2008-09 income year, and Determination G30 should be withdrawn at the same time. Taxpayers would be able to make any adjustments required as a result of suggestions in this issues paper in the 2008-09 income year.
1.8 Submissions are sought on these suggestions and on other IFRS-related issues. Officials will consider additional legislative changes if appropriate.
1.9 We would appreciate receiving any comments on the suggested changes by 20 October 2006.
1.10 Submissions should be sent to:
Tax Consequences of Adopting IFRS
C/- Deputy Commissioner, Policy
Policy Advice Division
Inland Revenue Department
P O Box 2198
1.11 Alternatively, submissions can be made in electronic form, in which case “Tax Consequences of Adopting IFRS” should appear in the subject line. The electronic address is:
1.12 Please note that submissions may be the subject of a request under New Zealand’s Official Information Act 1982. The withholding of particular submissions on the grounds of privacy, or for any other reason, will be determined in accordance with that Act. If there is any part of your submission that you consider could be properly withheld under that Act (for example, for reasons of privacy), please indicate this clearly in your submission.